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Why Shariah compliant annuities are still unavailable

The reasons are mainly the lack of demand but also the duration mismatch risk faced by providers. Devising Shariah compliant structures is not a major problem.

Posted 27 December 2021

In my view one of the most serious gaps in the Islamic finance market is the absence of Shariah compliant annuities.

I wrote about the need in my 2016 article "The need for Shariah compliant annuities." I returned to the subject in my December 2021 column for the magazine "Islamic Finance News" with my explanation for their absence from the Islamic finance market. You can read it below.

If there are some Shariah compliant annuity offerings which I have failed to find, I would appreciate readers sending me precise details. You can use the Disqus comments facility below, or email me as explained on the "Contact me" page.

Why can’t I find a Shariah compliant retirement annuity?

My “Letter from Amin” [my website page linked above] in the 13 April 2016 issue of Islamic Finance News explained the need for Shariah compliant retirement annuities that you could purchase with your accumulated pension fund once you retire. As I wrote:

“Annuities are particularly appropriate for individuals with relatively lower pension fund amounts or other savings who cannot afford to have the continuing investment risk throughout retirement which the second alternative [leaving the pension fund invested and making periodic cash withdrawals as the retiree requires money to spend] entails.”

Almost six years later, when I searched, I could not find anyone actually offering such annuities. Why is this?

The most obvious answer is the challenge of devising a Shariah compliant structure. On the face of it, handing over money in exchange for the promise to pay you a fixed income each year until you die looks like a contract of “riba” (impermissible increase). Riba is of course prohibited in Islam.

However, many people have proposed structures for providing retirement annuities that would be Shariah compliant. I could even construct one myself, using a takaful model.

In the same way that a takaful fund can pay you if the unfortunate event of dying occurs, it should be able to pay you every twelve months if you are suffering from still being alive! One is the mirror image of the other, and both create financial needs you need protecting against.

Indeed, commercially a takaful operator which already provides death cover is a natural provider of annuities, since the two products have naturally offsetting risks if there is a change in mortality experience. If people live longer than expected, the extra losses on the annuity business should be matched by greater profits on the death cover business.

Instead, I believe that the absence of annuity providers arises from a number of commercial factors:

  1. There is very limited demand. There is a saying in the United Kingdom that “life insurance is sold, not bought” meaning that people never think about buying life insurance. Instead, they only acquire it when a salesman persuades them that they need it. I suspect the same applies for retirement annuities, particularly since Muslim majority countries typically have very under-developed markets for long term savings products. (You need the accumulated fund with which to buy the annuity.)
  2. Market interest rates have been very low almost everywhere since the global financial crisis. That feeds through into lower yields on sukuk, and therefore a lower yearly annuity payment for each $1,000 of purchase price. In turn, potential buyers decide annuities are not “value for money.”
  3. Potential providers of retirement annuities have a serious mismatch problem. At present they cannot buy the long term sukuk that would match the long duration of annuity liabilities. If you are selling annuities that may last 20+ years, you need income generating assets with a similar duration. Unless the retirement annuity provider is very well capitalized, it cannot afford the risks of holding equities or short term sukuk as investments while selling long period annuities.

I don’t see this changing in the short run. Even in the conventional finance market, retirement annuities of the type discussed above are withering away as fewer and fewer people buy them.

Mohammed Amin is an Islamic finance consultant and former tax partner at PwC in the UK.


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